Environmental Valuation and its Applications Joshua Farley Community Development and Applied Economics Gund Institute for Ecological Economics University of Vermont

The Problem Finite planet subject to laws of thermodynamics… Finite planet subject to laws of thermodynamics… Can’t make something from nothing Can’t make something from nothing Energy, required for all production Energy, required for all production Raw materials, required for all economic production, essential to human survival Raw materials, required for all economic production, essential to human survival And laws of ecology… And laws of ecology… Raw materials are structural building blocks of ecosystems Raw materials are structural building blocks of ecosystems Loss of structure + pollution = loss of life support functions and other services, essential for survival of all species Loss of structure + pollution = loss of life support functions and other services, essential for survival of all species

The Problem Result is serious biophysical threats to human welfare and survival Result is serious biophysical threats to human welfare and survival Climate change and other forms of pollution Climate change and other forms of pollution Natural resource depletion Natural resource depletion Loss of biodiversity and ecosystem services Loss of biodiversity and ecosystem services Laws of economics Laws of economics When the marginal costs of an activity exceed the benefits, halt the activity When the marginal costs of an activity exceed the benefits, halt the activity Market fails to measure all costs and benefits Market fails to measure all costs and benefits

The Question Can monetary valuation of the environment help us balance marginal costs and marginal benefits? Can monetary valuation of the environment help us balance marginal costs and marginal benefits? We must truly understand the function of prices/value to answer this question We must truly understand the function of prices/value to answer this question

Outline Function of prices in a market economy and associated problems Function of prices in a market economy and associated problems Issues with monetary valuation of non- markets goods and services Issues with monetary valuation of non- markets goods and services When and how should we apply valuation? When and how should we apply valuation? Conclusions Conclusions

A Critical Perspective Function of Prices in a Market Economy

Functions of prices Measure value Measure value Maximize monetary value Maximize monetary value Allocation function Allocation function Rationing function Rationing function Measure scarcity Measure scarcity Accounting (briefly) Accounting (briefly)

Prices as a Measure of Value Do Prices Reflect Value? Do Prices Reflect Value? Diamond water paradox Diamond water paradox Use value vs. exchange value Use value vs. exchange value Exchange value = marginal value = price Exchange value = marginal value = price

Allocative function of price Apportions factors of production to whatever industry is willing to pay the most Apportions factors of production to whatever industry is willing to pay the most Generally the industry that can create most monetary value Generally the industry that can create most monetary value Maximizes monetary value across producers Maximizes monetary value across producers

Rationing function of price Apportions market products to whoever is willing to pay the most Apportions market products to whoever is willing to pay the most Maximizes monetary value across consumers Maximizes monetary value across consumers Value is preferences weighted by purchasing power Value is preferences weighted by purchasing power One dollar, one vote One dollar, one vote

Do Prices Always Maximize Monetary Value? Non-rival resource: use by one person does not leave less for others to use Non-rival resource: use by one person does not leave less for others to use Rationing is inefficient Rationing is inefficient Example of HCFCs and ozone hole Example of HCFCs and ozone hole Optimal price is zero Optimal price is zero Many ecosystem services are non-rival Many ecosystem services are non-rival

Is Monetary Value what we want to Maximize? Eflornithine: Perverse outcomes? Eflornithine: Perverse outcomes? What’s worth more, a tank full of ethanol for a fat American, or a plate full of tortillas for starving Mexicans? What’s worth more, a tank full of ethanol for a fat American, or a plate full of tortillas for starving Mexicans? Tyranny of the rich? Tyranny of the rich? One dollar one vote or one person one vote? One dollar one vote or one person one vote?

Price as measure of scarcity Scarcity  price increase  efficiency and innovation Scarcity  price increase  efficiency and innovation Does this even work for market goods? Does this even work for market goods?

Prices and Accounting Monetary value of food and energy as supplies contract Monetary value of food and energy as supplies contract Health care and GNP Health care and GNP

Conventional Economists: Missing the point…. Schelling (Nobel Memorial Prize in 2005): “Agriculture and Forestry are less than 3% of total output, and little else is much affected. Even if agricultural productivity declined by a third over the next half century, the per capita GNP we might have achieved by 2050 we would still achieve in 2051.” Schelling (Nobel Memorial Prize in 2005): “Agriculture and Forestry are less than 3% of total output, and little else is much affected. Even if agricultural productivity declined by a third over the next half century, the per capita GNP we might have achieved by 2050 we would still achieve in 2051.”

Issues with Valuation of Environmental Resources

Uncertainty, Ignorance, Irreversibility and Complexity Emergent phenomena, surprises, thresholds Emergent phenomena, surprises, thresholds Amazon, rainfall and the Cerrado Amazon, rainfall and the Cerrado Mata Atlantica, habitat loss, extinction and time lags Mata Atlantica, habitat loss, extinction and time lags Monetary values can be no more accurate than ecological knowledge Monetary values can be no more accurate than ecological knowledge

Incommensurability Not all things can be measured in same units Not all things can be measured in same units How much for your daughter? How much for your daughter?

Future Generations Cannot possibly bid in today’s markets Cannot possibly bid in today’s markets Monetary valuation assumes they have no rights. Monetary valuation assumes they have no rights.

Essential and Non-substitutable Benefits Small changes in quantity lead to large changes in value Small changes in quantity lead to large changes in value Unless system is static, by the time valuation studies are published, fed to decision makers and integrated into policy, they are wrong Unless system is static, by the time valuation studies are published, fed to decision makers and integrated into policy, they are wrong

The Case of Critical Natural Capital When and How do we Apply Valuation?

Critical Natural Capital Components of natural capital that are essential to human survival and for which there are no adequate substitutes Components of natural capital that are essential to human survival and for which there are no adequate substitutes Ecological thresholds Ecological thresholds Interdependent elements of complex system Interdependent elements of complex system

The Demand Curve for Natural Capital

Region 1 E.g. forests in Vermont E.g. forests in Vermont Price can determine conservation needs Price can determine conservation needs Estimate monetary value, provide information to decision makers, feed into market price (e.g. green taxes) Estimate monetary value, provide information to decision makers, feed into market price (e.g. green taxes) Only appropriate when rate of change in value is slow, i.e. region I Only appropriate when rate of change in value is slow, i.e. region I Far from threshold, errors not that important Far from threshold, errors not that important

Add value to cost of conversion (e.g. tax)

Region II Estimated price very sensitive to errors Estimated price very sensitive to errors Let knowledge of thresholds and other ecological criteria determine conservation needs Let knowledge of thresholds and other ecological criteria determine conservation needs Conservation needs then determine price Conservation needs then determine price Prices adjust to conservation constraints much more rapidly than ecosystems adjust to prices. Prices adjust to conservation constraints much more rapidly than ecosystems adjust to prices. E.g. laws (unenforced) limiting deforestation in Amazon E.g. laws (unenforced) limiting deforestation in Amazon International incentives essential International incentives essential

Conservation needs Price

Region III Restoration is essential Restoration is essential E.g. Atlantic Forest E.g. Atlantic Forest Time lags give us limited time to act Time lags give us limited time to act Economists should focus on supply curve, not demand curve Economists should focus on supply curve, not demand curve What is most cost effective way to restore critical natural capital? What is most cost effective way to restore critical natural capital?

Region III Finance more important than valuation Finance more important than valuation Must combine polluter pays principle, beneficiary pays principle Must combine polluter pays principle, beneficiary pays principle Trace flows of damages and benefits Trace flows of damages and benefits Wealthy countries must finance provision of global public good benefits, pay for costs of global climate change Wealthy countries must finance provision of global public good benefits, pay for costs of global climate change ICMS ecologico good model ICMS ecologico good model

Conclusions Worst approach is to assign no value to environment Worst approach is to assign no value to environment Environmental valuation can help determine when conservation is needed Environmental valuation can help determine when conservation is needed Calls attention to problem Calls attention to problem Can help in allocation when ecosystems are healthy, resilient Can help in allocation when ecosystems are healthy, resilient Economic values never better than ecological knowledge—close collaboration essential Economic values never better than ecological knowledge—close collaboration essential

Conclusions For stressed systems, conservation needs must determine environmental values For stressed systems, conservation needs must determine environmental values Economics take back seat to ecology Economics take back seat to ecology Many, many systems are stressed Many, many systems are stressed Global effort required to protect globally interconnected ecosystems Global effort required to protect globally interconnected ecosystems Beneficiary countries should pay provider countries Beneficiary countries should pay provider countries Ecologists/life scientists must educate economists on thresholds, criticality of natural capital Ecologists/life scientists must educate economists on thresholds, criticality of natural capital